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Here’s hoping your Thanksgiving holiday and weekend spent with loved ones were reasons to be thankful for the past year of blessings. Certainly, the markets didn’t give us much to be thankful or joyful for as all major market indexes dropped between 2.5% and 4.4% last week. Normally, Thanksgiving week can be counted on for an upside bias, but instead we got the worst Thanksgiving week since 2011 as the correction that began in early October rolls on.

As bad as the week was, we could be setting up for a pretty good rally into year end, if we could just get a positive spark of some sort this week. Some possible good news could be forthcoming on the trade war front from the G20 Summit, scheduled for November 30 and December 1, where President Donald Trump and China President Xi Jinping are scheduled to meet and have a discussion. This may bring hope for some type of agreement on the tit-for-tat tariffs imposed.

To be clear, the price action in the markets to-date has shown no evidence of a robust bounce coming, but there are some signs that a market reversal (upward) is brewing.

Market corrections, defined as a decline from the top of 10% or more, are always gut-wrenching and difficult to “watch”. In fact, this past week, the S&P 500 index finally closed 10.1% below the all-time high made in September. Under the surface, some stocks, specifically the technology and infamous FAANG stocks (Facebook, Apple, Amazon, Netflix and Google), have been hit hard with declines of up to 40% from their highs seen earlier this year. I could list a ton of stocks and market sectors that are in their own bear markets (20% below their recent highs), but you already know them because you probably own them.

Why the Long Face Mr. Market?

So what has the market in such a tizzy, seemingly all of a sudden, especially after a great 3rd quarter performance and record quarterly corporate earnings reported? A few things actually:

Trade Wars & Tariffs: Initially thought to be immune to the trade wars, the markets have succumbed to the thought that the current trade war may be drawn out, not just for months, but for years. While a minority of companies that reported earnings this past quarter pointed to tariffs as a concern, the ones that did, were very vocal about how a dragged out tariff war will significantly drag on future earnings. Needless to say, China features prominently in this picture, so a resolution next week would give Wall Street a reason to cheer.

Interest rates: There’s nothing like cheap money to keep the money flowing and the stock market buoyant, as companies issue bonds (debt) to buy back their shares in the open market and finance capital expansion plans. Home buying obviously works better with lower rates. So higher interest rates curb the debt appetite by companies and potential homeowners. In addition, investors, with the availability of lower risk and higher interest rate government bonds, will cash in their stocks for the safety of Uncle Sam’s treasury notes and bills. Why take all the stock market risk for an extra potential 1%-2% returns?

Economic Data Slowing: While gross domestic product, employment, consumer confidence and housing data have been near their highest levels, there are emerging signs of growth slowing in many areas of the economy. For example, home builder confidence dropped 8 points in November – now confirming the message that the housing market is slowing. The Conference Board’s Leading Economic Index barely eked out a gain of 0.1pts, which suggests that next month could see the first decline in over 29 months. Finally, durable goods (e.g., appliances, aircraft, machinery and equipment) orders for October came in worse than expected. While none of the data signifies an imminent recession, a slowdown in growth looks to continue, hardly surprising given the long slow economic recovery we’ve been in for almost ten years.

Oil Prices Crashing: Oil prices have lost over 35% from their highs in the first week in October. While lower oil prices mean more money in consumers’ pockets and higher profits for oil consumers such as airlines, the swift decline in prices unnerves investors and traders. Questions arise as to the robustness of the economy and worldwide demand for oil if the price can lose 1/3rd of its value in a period of less than two months.

When you consider that stock markets trade on future company profit expectations, all of the above worries weigh on prices investors are willing to pay for those future earnings. Companies may start to alert Wall Street that their initially published profit expectations may not be met. So, as a forward looking mechanism, the market starts to price in those worries 6-12 months before companies actually start to report those earnings.

Will Santa Claus Visit Wall Street This Year?

As mentioned above, there are some “green shoots” of hope that a rally may be near:

Investor Sentiment has been decimated in this correction. Any number of investor surveys, professional or retail (that’s you or me), has shown them to be despondent and sure this bull market is done and over with. In this business, excessive investor pessimism or optimism tends to act as a contrary indicator (when so many are sure the market will do one thing, the market tends to do another).

The markets are oversold in the short-term. When the selling has been as persistent as it has, without much in the way of a rally, the markets tend to reverse and rally up, if only for a day, a week, a month, or two.

Seasonality favors a rally. The period from mid-November through the following May tend to be very positive from a market standpoint. I should be clear in mentioning that seasonality has not worked very well at all in 2018 (e.g., August and September are usually down months but were up big this year).

We haven’t made a new market low in this correction since October 29. With the exception of some technology and NASDAQ stocks/indexes, the overall market has not made any new lows. While this could change when the markets open on Monday morning, the fact that the market didn’t push to new lows last week when it had the chance, means that we may be running out of sellers. In addition, some positive technical signs, one in the form of small capitalization stock strength on Friday, bode well for a potential near-term rally.

Although an interest rate increase of 0.25% is a 78% certainty in December, it’s possible that the federal reserve, when it meets in mid-December will signal a willingness to pull back on it’s plan for three interest rate hikes in 2019, given the apparent slow-down in economic growth.

Announced today (Sunday), the European Union and the United Kingdom have reached an agreement on Brexit. The removal of that uncertainty can help spark a rally.

So What Do We Do Now?

The weight of the evidence at the moment gives the benefit of doubt to the bears and the evident short-term downtrend. Therefore, caution is still warranted, even if a short-term rally emerges. Although the odds of a recession over the next 6-9 months remain very low, things can change in a hurry if the global slowdown continues or accelerates downward.

If you haven’t sold or trimmed any positions to-date, and you’re losing sleep over the market action, then you should take advantage of any rally to reduce your exposure to the markets to the “sleeping point” or add some hedges. It may be too late to sell right now, or into any further decline, but you should have your own plan for your investments that matches your risk tolerance, investment goals and time-frame. If you’re not a client, then I cannot possibly advise you, so this should not be construed as investment advice. Of course, if you would like to become a client, we’d love to talk to you.

For our clients, we lightened up on positions, raised cash and increased our hedges over the past several months as short-term signs pointed towards a bit of over-exuberance to the upside. We have tried dipping our toes lightly into a few positions during this correction, but mostly the market told us we were too early. Of course, stocks become more attractive as their prices decline, so dipping your toes into this decline is not a bad idea; just be sure you know your time-frame for holding, and be sure to keep it light until the trend changes upward, and the overall market acts as a tailwind rather than a headwind.

While markets are acting bearishly at this time, we remain alert to a switch in trend and hopeful that Santa comes to Wall Street, bringing a robust rally. Remember that a rally always comes around, so if your portfolio is down, there will be better days ahead if you want to buy or sell. Until then, remember that investing in stocks is great…as long as you don’t get scared out of them.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

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Yep, it’s that time of year again. While the stock markets were busy correcting in October, making for a very volatile month, our thoughts turn to year-end tax planning.

Now is the time to take steps to cut your 2018 tax bill. Here are some relatively foolproof year-end tax planning strategies to consider, taking into account changes included in the Tax Cuts and Jobs Act (TCJA).

Year-end Planning Moves for Individuals

Game the Increased Standard Deduction Allowances. The TCJA almost doubled the standard deduction amounts. For 2018, the amounts are $12,000 for singles and those who use married filing separate status (up from $6,350 for 2017), $24,000 for married joint filing couples (up from $12,700), and $18,000 for heads of household (up from $9,350). If your total annual itemizable deductions for 2018 will be close to your standard deduction amount, consider making additional expenditures before year-end to exceed your standard deduction. That will lower this year’s tax bill. Next year, you can claim the standard deduction, which will be increased a bit to account for inflation.

The easiest deductible expense to accelerate is your home mortgage payment due on January 1. Accelerating that payment into this year will give you 13 months’ worth of interest deductions in 2018. Although the TCJA put new limits on itemized deductions for home mortgage interest, you are most likely unaffected (mostly affects some interest on home equity loans and lines of credit).

Also, consider state and local income and property taxes that are due early next year. Prepaying those bills before year-end can decrease your 2018 federal income tax bill because your itemized deductions will be that much higher. However, the TCJA decreased the maximum annual amount you can deduct for state and local taxes to $10,000 ($5,000 if you use married filing separate status). So, beware of this new limitation, and don’t be in a hurry to pre-pay property taxes by year-end if there’s a better chance that you might be able to deduct them in 2019.

Accelerating other expenditures could cause your itemized deductions to exceed your standard deduction in 2018. For example, consider making bigger charitable donations this year and smaller contributions next year to compensate. Be sure to ask us about a donor advised fund, which can accelerate donation deductions this year, while taking your time (perhaps years) to “grant” amounts to your favorite charities. Also, consider accelerating elective medical procedures, dental work, and vision care. For 2018, medical expenses are deductible to the extent they exceed 7.5% of Adjusted Gross Income (AGI), assuming you itemize.

Warning: The state and local tax prepayment drill can be a bad idea if you owe Alternative Minimum Tax (AMT) for this year. That’s because write-offs for state and local income and property taxes are completely disallowed under the AMT rules. Therefore, prepaying those expenses may do little or no good if you are an AMT victim. While changes in the tax law reduced the number of people subject to the AMT, you may want to contact us if you are unsure about your exposure to the AMT.

Carefully Manage Investment Gains and Losses in Taxable Accounts. If you hold investments in taxable brokerage firm accounts, consider the tax advantage of selling appreciated securities that have been held for over 12 months. The maximum federal income tax rate on long-term capital gains recognized in 2018 is only 15% for most folks, although it can reach a maximum of 20% at higher income levels. The 3.8% Net Investment Income Tax (NIIT) also can apply at higher income levels.

To the extent that you have capital losses that were recognized earlier this year, or capital loss carryovers from pre-2018 years, selling winners this year will not result in any tax hit. In particular, sheltering net short-term capital gains with capital losses is a sweet deal because net short-term gains would otherwise be taxed at higher ordinary income rates.

What if you have some loser investments that you would like to unload? Biting the bullet and taking the resulting capital losses this year would shelter capital gains, including high-taxed short-term gains, from other sales this year.

If selling a bunch of losers would cause your capital losses to exceed your capital gains, the result would be what’s known as a net capital loss for the year. No problem! That net capital loss can be used to shelter up to $3,000 of 2018 ordinary income from salaries, bonuses, self-employment income, interest income, royalties, and whatever else ($1,500 if you use married filing separate status). Any excess net capital loss from this year is carried forward to next year and beyond.

In fact, having a capital loss carryover into next year could turn out to be a pretty good deal. The carryover can be used to shelter both short-term and long-term gains recognized next year and beyond. This can give you extra investing flexibility in those years because you won’t have to hold appreciated securities for over a year to get a preferential tax rate. Since the top two federal rates on net short-term capital gains recognized in 2019 and beyond are 35% and 37% (plus the 3.8% NIIT, if applicable), having a capital loss carryover into next year to shelter short-term gains recognized next year and beyond could be a very good thing.

One thing to keep in mind when either “harvesting” losses or holding on to winners to avoid capital gains: don’t let the tax “tail” wag the investment “dog”. Selling a loser for the sake of recognizing tax losses may not be prudent if the investment is temporarily undervalued. Conversely, holding onto an investment just to avoid capital gains taxes or to enjoy long term capital gains treatment may cost you more in lost gains than the taxes you’ll save. Be smart about it.

Take Advantage of 0% Tax Rate on Investment Income. The TCJA retained the 0%, 15%, and 20% rates on Long-term Capital Gains (LTCGs) and qualified dividends recognized by individual taxpayers. However, for 2018–2025, these rates have their own brackets that are not tied to the ordinary income brackets. Here are the brackets for 2018:

Single

Joint

Head of Household

0% bracket

$0–38,600

$0–77,200

$0–51,700

Beginning of 15% bracket

38,601

77,201

51,701

Beginning of 20% bracket

425,801

479,001

452,401

Note: The 3.8% NIIT can hit LTCGs and dividends recognized by higher-income individuals. This means that many folks will actually pay 18.8% (15% + 3.8% for the NIIT) and 23.8% (20% + 3.8%) on their 2018 LTCGs and dividends.

While your income may be too high to benefit from the 0% rate, you may have children, grandchildren, or other loved ones who will be in the 0% bracket. If you’re planning to give them cash, alternatively consider giving them appreciated stock or mutual fund shares that they can sell and pay 0% tax on the resulting long-term gains. Gains will be long-term as long as your ownership period plus the gift recipient’s ownership period (before the sale) equals at least a year and a day.

Giving away stocks that pay dividends is another tax-smart idea. As long as the dividends fall within the gift recipient’s 0% rate bracket, they will be federal-income-tax-free.

Warning: If you give securities to someone who is under age 24, the Kiddie Tax rules could potentially cause some of the resulting capital gains and dividends to be taxed at the higher rates that apply to trusts and estates. That would defeat the purpose. Please contact us if you have questions about the Kiddie Tax and refer to our post on the topic: Is Tax Simplification Just A Kiddie’s Play?

Also, one can be doing pretty well income-wise and still be within the 0% rate bracket for LTCGs and qualified dividends. Consider the following examples:

· Your married adult daughter files jointly and claims the $24,000 standard deduction for 2018. She could have up to $101,200 of AGI (including LTCGs and dividends) and still be within the 0% rate bracket. Her taxable income would be $77,200, which is the top of the 0% bracket for joint filers.

· Your divorced son uses head of household filing status and claims the $18,000 standard deduction for 2018. He could have up to $69,700 of AGI (including LTCGs and dividends) and still be within the 0% rate bracket. His taxable income would be $51,700, which is the top of the 0% bracket for heads of household.

· Your single daughter claims the $12,000 standard deduction for 2018. She could have up to $50,600 of AGI (including LTCGs and dividends) and still be within the 0% rate bracket. Her taxable income would be $38,600, which is the top of the 0% bracket for singles.

Give Away Winning Shares, or Sell Losing Shares and Give Away the Resulting Cash. If you want to make gifts to some favorite relatives and/or charities, they can be made in conjunction with an overall revamping of your taxable (non-IRA) stock and equity mutual fund portfolios. Gifts should be made according to the following tax-smart principles.

Gifts to Relatives. Don’t give away losing shares (currently worth less than what you paid for them). Instead, you should sell the shares and book the resulting tax-saving capital loss. Then, you can give the sales proceeds to your relative.

On the other hand, you should give away winning shares to relatives. It’s somewhat likely they will pay lower tax rates than you would pay if you sold the same shares. As explained earlier, relatives in the 0% federal income tax bracket for LTCGs and qualified dividends will pay a 0% federal tax rate on gains from shares that were held for over a year before being sold. (For purposes of meeting the more-than-one-year rule for gifted shares, you can count your ownership period plus the gift recipient’s ownership period.) Even if the winning shares have been held for a year or less before being sold, your relative will probably pay a much lower tax rate on the gain than you would.

Gifts to Charities. The principles for tax-smart gifts to relatives also apply to donations to IRS-approved charities. You should sell losing shares and benefit from the resulting tax-saving capital losses. Then, you can give the sales proceeds to favored charities and claim the resulting tax-saving charitable deductions (assuming you itemize). Following this strategy delivers a double tax benefit: tax-saving capital losses plus tax-saving charitable donation deductions.

On the other hand, you should donate winning shares instead of giving away cash. Why? Because donations of publicly traded shares that you have owned for over a year result in charitable deductions equal to the full current market value of the shares at the time of the gift (assuming you itemize). Plus, when you donate winning shares, you escape any capital gains taxes on those shares. This makes this idea another double tax-saver: you avoid capital gains taxes, while getting a tax-saving donation deduction (assuming you itemize). Meanwhile, the tax-exempt charitable organization can sell the donated shares without owing anything to the IRS.

Finally, if you’re over age 70-1/2, you are subject to annual required minimum distributions (RMD) on your traditional IRA accounts. Consider making a direct contribution from your IRA to your favorite charity for any amount and it applies towards your annual RMD obligation. That way, the income is never taxed, and reduces your overall AGI, which can benefit you in many ways (e.g., possibly lower medicare premiums, less taxation of social security benefits, less exposure to deduction phaseouts that are based on your AGI).

Convert Traditional IRAs into Roth Accounts. The best profile for the Roth conversion strategy is when you expect to be in the same or higher tax bracket during your retirement years. The current tax hit from a conversion done this year may turn out to be a relatively small price to pay for completely avoiding potentially higher future tax rates on the account’s earnings.

A few years ago, the Roth conversion privilege was a restricted deal. It was only available if your modified AGI was $100,000 or less. That restriction is gone. Even billionaires can now do Roth conversions! If you have a lower than normal maximum tax bracket, you may want to consider a Roth conversion before year end.

Take Advantage of Principal Residence Gain Exclusion Break. Home prices are on the upswing in many areas. More good news: Gains of up to $500,000 on the sale of a principal residence are completely federal-income-tax-free for qualifying married couples who file joint returns. $250,000 is the gain exclusion limit for qualifying unmarried individuals and married individuals who file separate returns. To qualify for the gain exclusion break, you normally must have owned and used the home as your principal residence for a total of at least two years during the five-year period ending on the sale date. You’ll definitely want to take these rules into consideration if you’re planning on selling your home in today’s improving real estate environment.

Watch out for the AMT. The TCJA significantly reduced the odds that you will owe AMT for 2018 by significantly increasing the AMT exemption amounts and the income levels at which those exemptions are phased out. Even if you still owe AMT, you will probably owe considerably less than under prior law. Nevertheless, it’s still critical to evaluate year-end tax planning strategies in light of the AMT rules. Because the AMT rules are complicated, you may want some assistance. We can help.

Don’t Overlook Estate Planning. The unified federal estate and gift tax exemption for 2018 is a historically huge $11.18 million, or effectively $22.36 million for married couples. Even though these big exemptions may mean you are not currently exposed to the federal estate tax, your estate plan may need updating to reflect the current tax rules. Also, you may need to make some changes for reasons that have nothing to do with taxes, especially if your estate plan is more than a few years old. Don’t put off this very important life planning task.

Year-end Planning Moves for Small Businesses

Establish a Tax-favored Retirement Plan. If your business doesn’t already have a retirement plan, now might be the time to take the plunge. Current retirement plan rules allow for significant deductible contributions. For example, if you are self-employed and set up a SEP-IRA, you can contribute up to 20% of your self-employment earnings, with a maximum contribution of $55,000 for 2018. If you are employed by your own corporation, up to 25% of your salary can be contributed with a maximum contribution of $55,000.

Other small business retirement plan options include the 401(k) plan (which can be set up for just one person), the defined benefit pension plan, and the SIMPLE-IRA. Depending on your circumstances, these other types of plans may allow bigger deductible contributions.

The deadline for setting up a SEP-IRA for a sole proprietorship, and making the initial deductible contribution for the 2018 tax year, is 10/15/2019 if you extend your 2018 return to that date. Other types of plans generally must be established by 12/31/2018 if you want to make a deductible contribution for the 2018 tax year, but the deadline for the contribution itself is the extended due date of your 2018 return. However, to make a SIMPLE-IRA contribution for 2018, you must have set up the plan by October 1. So, you might have to wait until next year if the SIMPLE-IRA option is appealing.

Contact us for more information on small business retirement plan alternatives, and be aware that if your business has employees, you may have to cover them too.

Take Advantage of Liberalized Depreciation Tax Breaks. Thanks to the TCJA, 100% first-year bonus depreciation is available for qualified new and used property that is acquired and placed in service in calendar year 2018. That means your business might be able to write off the entire cost of some or all of your 2018 asset additions on this year’s return. So, consider making additional acquisitions between now and year-end. Contact us for details on the 100% bonus depreciation break and what types of assets qualify.

Claim 100% Bonus Depreciation for Heavy SUVs, Pickups, or Vans. The 100% bonus depreciation provision can have a hugely beneficial impact on first-year depreciation deductions for new and used heavy vehicles used over 50% for business. That’s because heavy SUVs, pickups, and vans are treated for tax purposes as transportation equipment that qualifies for 100% bonus depreciation. However, 100% bonus depreciation is only available when the SUV, pickup, or van has a manufacturer’s Gross Vehicle Weight Rating (GVWR) above 6,000 pounds. The GVWR of a vehicle can be verified by looking at the manufacturer’s label, which is usually found on the inside edge of the driver’s side door where the door hinges meet the frame. If you are considering buying an eligible vehicle, doing so and placing it in service before the end of this tax year could deliver a juicy write-off on this year’s return.

Claim Bigger First-year Depreciation Deductions for Cars, Light Trucks, and Light Vans. For both new and used passenger vehicles (meaning cars and light trucks and vans) that are acquired and placed in service in 2018 and used over 50% for business, the TCJA dramatically increased the so-called luxury auto depreciation limitations. For passenger vehicles that are acquired and placed in service in 2018, the luxury auto depreciation limits are as follows:

· $18,000 for Year 1 if bonus depreciation is claimed.
· $16,000 for Year 2.
· $9,600 for Year 3.
· $5,760 for Year 4 and thereafter until the vehicle is fully depreciated.

These allowances are much more generous than under prior law. Note that the $18,000 first-year luxury auto depreciation limit only applies to vehicles that cost $58,000 or more. Vehicles that cost less are depreciated over six tax years using depreciation percentages based on their cost. Contact us for details.

Cash in on More Generous Section 179 Deduction Rules. For qualifying property placed in service in tax years beginning in 2018, the TCJA increased the maximum Section 179 deduction to $1 million (up from $510,000 for tax years beginning in 2017). The Section 179 deduction phase-out threshold amount was increased to $2.5 million (up from $2.03 million). The following additional beneficial changes were also made by the TCJA.

Property Used for Lodging. For property placed in service in tax years beginning in 2018 and beyond, the TCJA removed the prior-law provision that disallowed Section 179 deductions for personal property used predominately to furnish lodging or in connection with the furnishing of lodging. Examples of such property would apparently include furniture, kitchen appliances, lawn mowers, and other equipment used in the living quarters of a lodging facility or in connection with a lodging facility such as a hotel, motel, apartment house, dormitory, or other facility where sleeping accommodations are provided and rented out.

Qualifying Real Property. As under prior law, Section 179 deductions can be claimed for qualifying real property expenditures, up to the maximum annual Section 179 deduction allowance ($1 million for tax years beginning in 2018). There is no separate limit for qualifying real property expenditures, so Section 179 deductions claimed for real property reduce the maximum annual allowance dollar for dollar. Qualifying real property means any improvement to an interior portion of a nonresidential building that is placed in service after the date the building is first placed in service, except for expenditures attributable to the enlargement of the building, any elevator or escalator, or the building’s internal structural framework.

For tax years beginning in 2018 and beyond, the TCJA expanded the definition of real property eligible for the Section 179 deduction to include qualified expenditures for roofs, HVAC equipment, fire protection and alarm systems, and security systems for nonresidential real property. To qualify, these items must be placed in service in tax years beginning after 2017 and after the nonresidential building has been placed in service.

Time Business Income and Deductions for Tax Savings. If you conduct your business using a pass-through entity (sole proprietorship, S corporation, LLC, or partnership), your shares of the business’s income and deductions are passed through to you and taxed at your personal rates. Assuming the current tax rules will still apply in 2019, next year’s individual federal income tax rate brackets will be the same as this year’s (with modest bumps for inflation). In that case, the traditional strategy of deferring income into next year while accelerating deductible expenditures into this year makes sense if you expect to be in the same or lower tax bracket next year. Deferring income and accelerating deductions will, at a minimum, postpone part of your tax bill from 2018 until 2019.

On the other hand, if you expect to be in a higher tax bracket in 2019, take the opposite approach. Accelerate income into this year (if possible) and postpone deductible expenditures until 2019. That way, more income will be taxed at this year’s lower rate instead of next year’s higher rate. Contact us for more information on timing strategies.

Maximize the New Deduction for Pass-through Business Income. The new deduction based on Qualified Business Income (QBI) from pass-through entities was a key element of the TCJA. For tax years beginning in 2018–2025, the deduction can be up to 20% of a pass-through entity owner’s QBI, subject to restrictions that can apply at higher income levels and another restriction based on the owner’s taxable income. The QBI deduction also can be claimed for up to 20% of income from qualified REIT dividends and 20% of qualified income from publicly-traded partnerships.

For QBI deduction purposes, pass-through entities are defined as sole proprietorships, single-member LLCs that are treated as sole proprietorships for tax purposes, partnerships, LLCs that are treated as partnerships for tax purposes, and S corporations. The QBI deduction is only available to non-corporate taxpayers (individuals, trusts, and estates).

Because of the various limitations on the QBI deduction, tax planning moves (or non-moves) can have the side effect of increasing or decreasing your allowable QBI deduction. So, individuals who can benefit from the deduction must be really careful at year-end tax planning time. We can help you put together strategies that give you the best overall tax results for the year.

Claim 100% Gain Exclusion for Qualified Small Business Stock. There is a 100% federal income tax gain exclusion privilege for eligible sales of Qualified Small Business Corporation (QSBC) stock that was acquired after 9/27/10. QSBC shares must be held for more than five years to be eligible for the gain exclusion break. Contact us if you think you own stock that could qualify.

Conclusion

This post only covers some of the year-end tax planning moves that could potentially benefit you and your business. Please contact us if you have questions, want more information, or would like us to help in designing a year-end planning package that delivers the best tax results for your particular circumstances.

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Last week was one of the “worst” for the stock markets in many months, even though the S&P 500 index was barely down 1%, and the Dow Jones Industrial average remained virtually unchanged. However, the tech-heavy NASDAQ lost 3.2% and small capitalization stocks were down 3.8%. International stocks declined about 2.35%.

The proximate “cause” of the weekly decline was blamed on fast rising bond yields (when bond yields go up, that means bond prices go down). The ten-year treasury note yield rose 0.16% to 3.2%, while the 30-year treasury bill rose 0.20% to 3.4%. These are their highest levels since July 2011 and August 2014 respectively.

Despite a weaker than expected September monthly jobs report, with 134,000 jobs added in September (185,000 were expected), we are seeing wages grow 2.8% year-over-year, while the unemployment rate has declined to match the low of 3.7%, last seen in 1969. Wage inflation is the biggest threat to stable prices, and portends more aggressive interest rate hikes by the federal reserve in the future.

Too Much of a Good Thing?

With the economy hitting on all cylinders, jobs are plentiful and consumers are extraordinarily confident. In fact, the latest survey from the Conference Board puts the September reading of the Consumer Confidence Index at the highest reading since September 2000. Paradoxically, frothy confidence and complacency typically coincide with a run up to a final bull (up-trending) market peak. With five out of the last seven bull market tops over the last 52 years, exceptionally bright consumer outlooks peaked coincidentally with the S&P 500, and declined with the onset of a bear (down-trending) market. The only exceptions were 1980 and 1987, when the bear declines were driven by an abrupt monetary shock. So even though we are in the midst of a “Goldilocks” economy, a significant downturn in consumer confidence could negatively impact the economic outlook.

Since the financial crisis of 2009, the Federal Reserve has kept interest rates abnormally low, and is currently committed to a gradual path to normalization. There is a fear, however, that the Fed might fall behind the curve and could be forced to move faster than expected. That increases concerns that interest rates might push the economy into a recession.

Time to Get Defensive?

Over the past couple of weeks, as the number of stocks that were advancing (versus those that were declining) saw deterioration (despite the indexes setting new all-time highs), we started getting more defensive in client (and my personal) investment portfolios by selling some partial positions and increasing market hedges. This past week, we saw some further stalling and heavier volume selling in the markets than we have seen in quite a few months. For client portfolios, we already had reduced exposure to the markets, and with the recent increased institutional selling, I plan to slightly further reduce exposure on rallies in the coming weeks.

Everybody seems to be expecting a 4th quarter (November/December) post-mid-term election rally, which makes me a bit suspicious that we might not get one. The 3rd quarter of a mid-term election year is usually biased to the downside, but instead, this time around, we went on to make new all-time highs. Did we pull forward 4th quarter returns into the 3rd quarter? We’ll soon find out.

If you’re not inclined to sell anything, thereby recognizing capital gains this year, you could consider 1) making use of inverse funds (also referred to as bear market funds); 2) buy put options to hedge your portfolio; and/or 3) sell call options against stock and ETF positions on bounce-backs, the first of which I expect to see early this coming week.

But don’t let the tax “tail” wag the investment “dog”; take some chips off the table while you can, not when you’re forced to. In these algorithmic and high-frequency trader driven markets today, the velocity to the downside, as we saw in January earlier this year, can be stunning. Also, don’t forget that if you sell something in your IRA or 401(k), you won’t be generating any taxable capital gains.

With interest rates clearly headed higher, I wouldn’t be moving money from stocks to bonds as a defensive measure right now. As this past week attests, both bonds and stocks can go down at the same time, leaving cash or inverse funds as a couple of feasible places to “hide out” on a fraction of your overall investment portfolio. A buy point in bonds will be coming soon, but one should wait until they stabilize. If you find yourself overweight in bond exposure, a rally is sure to come, which you should take advantage of to reduce exposure.

Know Your Risk

To be clear, I may be early & wrong, but growth and bellwether names have been getting hit hard of late. Any measure of risk management over the last 9-1/2 years has reduced overall returns to be sure. And if you have a very long term time horizon, this may turn out to be a garden variety 5-15% pullback on our way to new highs, so you may choose to do nothing.

With interest rates finally rising meaningfully, institutions showing some inclinations towards selling (which we haven’t seen since January-February), some key sectors faltering (such as financials and housing), and consumer confidence at all-time highs, this is a time to protect market profits and capital. If you’re fully invested, it can’t hurt to take some of your bull market gains off the table.

As mentioned above, the current period around mid-term election years is usually a strong one, and economic and corporate profit strength are at record highs, so this may be a normal correction on our way to new stock market highs. The last quarter of this year and first quarter of next year have historically been very strong, and that’s what I’m expecting. But just in case it isn’t, it may be prudent to somewhat reduce exposure here.

I am not calling for a bear market or market crash. I see nothing out there to panic about right now. You can bet that if I see anything like that brewing, you’ll be hearing from me again, urging you to drastically reduce market exposure.

As always, this article is not a recommendation to buy or sell any securities. I may not be your portfolio manager or financial planner, know little to nothing about your risk tolerance, time-frame or financial goals, so I can’t really advise you. I am only sharing what I’m seeing after a prolonged run in a persistently accommodative monetary environment, which is getting less so (central banks, federal reserve tightening monetary policy and raising rates). This might turn out to be the pull-back to buy instead of sell, but if you don’t have cash ready on the side to invest, can you really take advantage of it?

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Clients and prospects talk to me all the time about their current car ownership picture and future purchase needs. Most seem wedded to the traditional model of one car per spouse, plus a car for each licensed child living at home. While the use of car sharing services such as Uber and Lyft are going full tilt, not many are thinking about the coming driver-less revolution. Most are not quite ready to give up their current car ownership habits.

But if you’re in the market for a new or used car either now or in the near future, or just interested in investing in the future of autonomous auto-making, this might help change your thinking about being a multiple or even single-car family. I’ve borrowed much of a recent write-up from Jon D. Markman (used with permission).

From ownership to propulsion and operation, car making is at a point of inflection. Power brokers are scrambling to find new business models, and slow the process.

CNBC ran a story a few weeks ago about public frustration with Alphabet’s (Google) self-driving car program in Arizona. The robot vehicles are so cautious that human drivers can’t see their utility.

It’s disinformation passing for common sense. For investors, it’s dangerous.

Global sales of passenger vehicles reached 78.6 million units in 2017. Toyota Motor, the largest manufacturer, logged sales of $265 billion last year. This business is being disrupted right now. The same is true for auto parts, dealer networks, maintenance and repair infrastructure and the five-trillion dollar oil industry.

None of these deep-pocketed interests benefit from cars quickly becoming more safe, reliable or electric. They need to slow down the process, while they look for and find new business models. Stories that promote the myth that new technologies are less safe, and ultimately will do more harm than good, are a help to them.

An Associated Press report about an electric car catching fire became a global news story in June. It helped that the vehicle in question was parked, a Tesla, and owned by a celebrity. However, the story lacked perspective.

In 2015, the most recent year for which records have been kept, the National Fire Protection Association reported approximately 174,000 gasoline vehicle fires. It turns out that gas is flammable–go figure, and prone to spontaneous combustion.

In March, an SUV decked out with the latest sensors, cameras and self-driving software from Uber, struck and killed a pedestrian in Tempe, Arizona. The test vehicle did not slow or swerve. The ride-along human observer did not take the wheel. Video captured from the vehicle showed her looking down at her smartphone moments before impact.

Although, the tragedy became an indictment of autonomous vehicle technology, the National Highway Traffic Safety Administration reported that 5,376 pedestrians were killed in traffic crashes in the U.S. in 2015. Some 129,000 were treated for injury.

The numbers are not surprising. Humans are terrible drivers. We are far too easily distracted by children in the backseat, the radio, or our smartphones. And we are impatient to a fault.

Recent data from the California Department of Motor Vehicles reveals 38 accidents involving moving AVs since 2014. The AV was found at fault in only one case.

As a long time writer, I love a good-dog-bites-man story. Everyone does. But the idea that electric cars and AVs are the problem is dangerous, especially for investors. (the image above is a Renault concept car for an autonomous ride-hailing service.)

The automobile industry is headed toward autonomous, electric vehicles. Years from now, owning a car will make no more sense than owning music or movies today. Most legacy business models must change or ultimately fail. Car makers know this.

It’s why every leading car maker is moving production toward electric propulsion. Volkswagen, now the largest carmaker by volume, plans to offer 80 new electric vehicles by 2025. Even Dyson, best known for its snazzy vacuums and fans, is going to build electric cars.

It’s why Volvo and BMW are experimenting with vehicle subscriptions. For a single fee, subscribers get to change cars whenever they want, insurance and maintenance included.

It’s why iconic car brands are pairing with ride hailing startups all over the globe. In the future, selling fleets of vehicles and taking a piece of new Mobility-as-a-Service models, will be the business.

It’s why Toyota will invest $500 million with Uber to develop autonomous vehicles.

It’s why Bosch, the largest auto part supplier in the world, is working with Nvidia (NVDA) to build the trunk mounted supercomputers to power autonomous vehicle software.

And it’s why chip and processor giant Intel (INTC) bought Mobileye, which makes software for autonomous driving, last year for about $15 billion. Back then, Intel also announced that it planned to build a fleet of 100 highly automated vehicles to test in the U.S., Europe and Israel. Two million vehicles from car makers BMW, Nissan and Volkswagen will use technology from Mobileye to build high-definition maps throughout 2018. Those maps would then be used by autonomous vehicles for navigation.

This is the state of the car business. The transition is happening. It’s not hype. It’s real.

Investors are doing themselves real harm buying into the idea the technology is faulty, or decades away from adoption. Even if you’re not a potential investor in the driverless-car revolution, you might think twice about buying that next or second car to park in your garage. Heck, you might even add a monthly car “subscription” to your Apple Music and Netflix subscriptions one day.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Like this:

You’ve probably heard by now that the IRS plans to issue a post-card sized 2018 tax form to allow taxpayers with the simplest of returns to file on. While “tax simplification” is an admirable goal, is it really possible when the objectives of the tax code are to meet and balance social, political and revenue goals/needs? Let’s just say that, as a CPA who prepares tens of returns each year, I have no worries about job security in my lifetime.

Tax simplification is one of the biggest misnomers coming out of Washington, where Congress purportedly makes it easier for all of us to fill out our tax returns by adding several thousand pages of new rules, rates and lists of things we can and cannot deduct under new lists of circumstances. The most recent version, which includes a complicated deduction for individuals participating in S corporations, partnerships, LLCs and sole proprietorships (with regulations running no fewer than 184 pages); new rules governing the deduction of alimony payments; what new payments can be made, tax-free, out of 529 plans; and restrictions on state and local tax deductions for federal tax purposes, are excellent examples of more complexity, not less.

But one actual reduction in complexity came with reform to the so-called “Kiddie Tax.” Under the old law (warning: get ready for some real complexity), a dependent child under the age of 18, or under 19 who provides less than 50% of his/her support, or a full-time student under the age of 24 would divide his/her income into two buckets: earned and unearned (investment) income. If parents claimed the child as a dependent on their tax return, the child’s standard deduction would be the greater of $1,050 or the child’s earned income (W-2), plus $350 (limited to the standard deduction amount of the parents). If the unearned income was more than $2,100, the investment income—but not the earned income—would be taxed at the tax rate of the highest-income parent. Did you get all that?

Under the new 2017 tax act, each child’s tax is calculated using the tax rates that apply to trusts, rather than the parents’ tax rates. Unlike individuals, trusts have just four brackets for ordinary income: 10% (up to $2,550), 24% ($2,551-$9,150), 35% ($9,151-$12,500) and 37%, with the top rate applied to all income over $12,500. For long-term capital gains, different rates apply.

Of course, that means that children get to the highest tax rate with far less income than, for example, married individuals (where the top rate kicks in above $600,000 in taxable income) or heads of household ($500,000). But at least the calculation is simpler—certainly a rarity in our history of tax “simplification.”

For children with expected investment income greater than $2,550, and especially over $9,150, it’s worth examining whether the “income shifting” planning that is currently in place, still makes sense. Setting up and funding custodial accounts for minors, going forward, definitely won’t be as simple as it once was.

If we can be of help with setting up custodial accounts or planning kiddie income, or if you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

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I often remind my clients and prospects that judging market performance for periods shorter than a few years, isn’t very helpful. Market returns are simply random over relatively brief periods. However, over longer periods, such as five years, stocks are almost always profitable and offer very good performance. The S&P 500 has finished higher in 91% of the rolling-five-year periods over the last 50 years.

Nonetheless, it’s helpful to check back and see how well the markets performed over the past quarter While the U.S. equity markets suffered a small setback in the first quarter of 2018, the second quarter brought us back into positive territory.

The Wilshire 5000 Total Market Index—the broadest measure of U.S. stocks—finished the quarter up 3.83%, and is now in positive territory for the first half of the year, at +3.04%. The comparable Russell 3000 index is up 3.22% so far this year.

Large cap stocks more than recovered their earlier losses. The Wilshire U.S. Large Cap index gained 3.41% over the past three months, to finish up 2.62% for the first half of the year, while the Russell 1000 large-cap index stands at a 2.85% gain at the year’s halfway point. The widely-quoted S&P 500 index of large company stocks gained 2.93% in value during the year’s second quarter, rallying to a 1.67% gain so far in 2018.

Meanwhile, the Russell Midcap Index is up 2.35% in the first six months of the year.

As measured by the Wilshire U.S. Small-Cap index, investors in smaller companies posted a 7.87% gain over the second three months of the year, and now stand up 7.08% at the half-year mark. The comparable Russell 2000 Small-Cap Index is up 7.66% for the year. The technology-heavy Nasdaq Composite Index finished the quarter with a gain of 6.31%, and is now up 8.79% at the halfway point of 2018. Much of the over-performance of the NASDAQ can be attributed to a handful of stocks such as Amazon, Facebook, Google and Neflix.

International stocks are not faring quite so well. The broad-based MSCI EAFE index of companies in developed foreign economies lost 2.34% in the recent quarter, and is now down 4.49% for the year. In aggregate, European stocks were down 2.74% over the last three months, posting an overall loss of 5.23% for the year, while MSCI’s EAFE’s Far East Index lost 3.24% in the second quarter, down 3.33% so far in 2018. Emerging market stocks of less developed countries, as represented by the MSCI EAFE EM index, went into negative territory for the quarter, down 8.66%, for a loss of 7.68% for the year.

Looking over the other investment categories, real estate, as measured by the Wilshire U.S. REIT index, gained 9.73% during the year’s second quarter, and is just eking out a 1.52% gain for the year. The S&P GSCI index, which measures commodities returns, gained 8.00% in the second quarter, up 10.36% for the year, mainly due to the rising price of oil.

In the bond markets, coupon rates on 10-year Treasury bonds have continued an incremental rise to 2.86%, while 30-year government bond yields have risen slightly to 2.99%. Five-year municipal bonds are yielding, on average, 2.00% a year, while 30-year munis are yielding 3.00% on average. Simply put, at present, investing in bonds with a term greater than 10 years is not rewarding you for the many years of interest rate risk you’re taking. That may change.

So what’s going on? There appear to be several forces fighting for control over the investment markets. The current bull market started in March of 2009, and seemed to be running out of steam in the first quarter, before a sugar high—the stimulus provided by the recent tax bill—kicked in for companies that have traditionally experienced higher tax rates. This pushed a tired bull market forward for another quarter, and could do the same for the remainder of the year. A fiscal stimulus in the ninth year of an economic expansion is almost unheard of, but it is clearly having a positive effect: economic activity was up nearly 5% in the second quarter, unemployment has continued a downward trend that really started at the beginning of the bull market, and corporate earnings—with the lower corporate taxes factored in—are projected to increase roughly 25% over last year.

The other contestants for control of the economy seem destined to lose this year and possibly start winning in 2019. The Federal Reserve Board has raised short-term interest rates once again, and has announced plans to continue in September, December, next March and next June. Bonds’ share of investors’ dollars at some point will overtake stocks as government 10 year bond yields reach 4% or more, making it difficult for stocks to levitate at current levels.

Meanwhile, the labor markets are so tight that there are more jobs available than workers to fill them. Won’t this eventually force companies to share their profits in the form of higher salaries? And there are potential problems with the escalating trade war that America has picked with its trading partners that will almost certainly not have a positive impact in the long term.

Bigger picture, the flattening yield curve—where longer-term bonds are closer to yielding what shorter-term instruments are paying—is never regarded as a good sign for an economy’s near-term future. It’s worth noting that the financial sector—that is, lending institutions—was one of the economic sectors to experience a loss. Banks borrow short and lend long, and there isn’t much profit in that activity when the rates are about equal.

Beyond that, in a good year, corporate earnings would grow around 5%, so one could argue that the economy is now experiencing five years of earnings growth. Add these factors to the doddering age of the current bull market, and you have to wonder how long the party can continue. Nobody knows what tomorrow will bring, but everybody knows that bull (up-trending) markets don’t last forever. This may be a good time to mentally and financially prepare for an end to the long bull run, and to hope it ends gracefully. For our clients, we remain cautious bulls and are keeping our hedges in place. The higher volatility we’ve experienced so far this year shows no sign of waning, and the low-volume summer trading season is the ideal time for market shenanigans to show up.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

With about 10,000 baby boomers on average retiring every day, it’s not unusual for me to talk to clients and prospects who are anxious about the future of social security and medicare. Some clients, despite evidence and advice to the contrary, have gone ahead and filed for social security benefits even if it meant they would potentially reap hundreds of thousands of dollars less over their lifetimes, because they are worried that the systems are going “bankrupt”.

Given the stories and rumors that seem to float around endlessly about the imminent demise of social security and medicare, it is understandable that many were alarmed when, on June 5, the good people who run Medicare and Social Security released a report that said that the Medicare program will become insolvent in 2026 and Social Security will face a similar fate in 2034. The Medicare projection is three years earlier than the previous report, while the Social Security projection is unchanged from previous estimates.

These problems are not new, of course. People are living far longer than anticipated when Social Security was created in 1935; in fact, the average life expectancy for a person who managed to reach age 30 at that time was age 68 for men and 70 for women. Today it’s 79 for men and 82 for women. Meanwhile, Medicare has been hit with higher-than-inflation increased medical expenses—along with, of course, those longer lifespans.

Alarmists point out that the Social Security and Medicare Trust Fund reserves are “invested” in government securities, which is essentially the government writing itself an IOU—currently to the tune of $2.8 trillion, which is the total “asset reserves” in our largest social programs. Individuals are advised not to run their own finances this way, accumulating deficits but meticulously keeping slips of paper around which represent a promise to pay back every single nickel and dime eventually. But in fact, today nearly all of the money paid out to Social Security recipients, and on behalf of Medicare enrollees, are simply transfers of money paid into the program by current workers. The money comes in as FICA payments and taxes on Social Security benefits, and goes right back out the door to beneficiaries. We’ve all heard the expression that “our government is running the world’s largest Ponzi scheme”.

So where’s this alleged deficit? That can be found on page 9 of the report, in a section labeled “Assumptions About the Future.” There, the report makes economic projections about the next 75 years, including the future fertility rate (children per woman), mortality, the annual percentage change in worker productivity, average annual wage increases, inflation, unemployment and the interest rate earned by those IOUs the government is writing to itself. Page 18 shows a graph that illustrates the projected outcomes of three different sets of assumptions for all these (basically unknowable) variables, and one can see that two of them are, shall we say, not optimal, while the third projects not just solvency, but actual prosperity for the combined trust funds going forward well past the year 2090.

Even if the worst case comes to pass, and the programs goes “bust,” they won’t actually stop paying benefits. There will still be workers who pay in FICA taxes, and even if there is no trust fund, these collected payroll taxes can be transferred, as they are now, to Social Security and Medicare recipients. The Social Security trustees report, on page 58, how much of the projected payments would be covered by workers going out to 2090 under the three future scenarios. The worst case scenario says that there will be roughly an 18% shortfall in 2040, rising to roughly 22% by 2090. Basically, that means that Social Security recipients, worst case scenario, would have to get by on 82% of the benefits they were expecting in 2040, and 78% if they manage to live all the way out to 2090.

And, of course, that’s if nothing is done to shore up the program between now and then. One of the simplest options on the table is to raise the age people can collect full retirement benefits as the average lifespan goes up, basically “indexing” retirement benefits to changes in longevity. Congress could also marginally raise FICA taxes (e.g., the taxable wage limit) or impose more taxes on Social Security income. Minor tweaks to the system can add decades to the solvency of social security and medicare.

The best advice here is not to panic about the fate of our country’s social programs. There is no question we need to address their solvency, and with gridlock in Washington, that seems like a bit of a long shot. But even if Congress can’t agree on tweaks and fixes, the world won’t come to an end. Social Security and Medicare recipients will have to tighten their belts a bit—and maybe start voting for candidates who offer real solutions to the budget issues in Washington. But as I’ve told my clients for years, no one is going to vote for anyone who favors allowing the system to go bankrupt, or not pay the promised benefits. Members of congress really like keeping their jobs, and eventually they’ll find the right solutions.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.